Futures Trading

Whether or not trading futures contracts is worth it depends on an investor’s investing strategy, risk tolerance and time horizon. While futures offer some unique benefits, such as increased leverage and lower trading costs, they also come with some significant risks that should be considered carefully before beginning to trade them.

One of the most important things for a new investor to realize is that futures are not the same as stocks. While many people think that trading futures is simply a matter of predicting the price of an underlying commodity, there are several other complexities to consider. One of the most important is that losses in a futures trade aren’t capped at the initial purchase price. Because of this, it is possible for a trader to lose large sums of money, even if they correctly predicted the direction of the market.

To mitigate this risk, futures traders must put up an initial margin of a certain percentage of the contract value, which is deposited with their broker or exchange to hold in reserve in case of a loss. This initial margin can be substantial, especially with the leverage that is typically available on a futures contract, so it’s crucial to understand this risk before beginning to trade.

Is Futures Trading Worth It?

In addition to the risk of losing a portion of their investment, investors should remember that there are also additional transaction fees involved with trading futures. Because of this, it’s often necessary for traders to weigh the total cost of a position against their anticipated profit. This is particularly important for those who trade futures with a full service broker, which can charge up to $50 per side on every trade.

As a result of this, it’s usually not worth it for beginner investors to attempt to make large profits on small changes in the market. Instead, they should focus on establishing a long-term investment plan that includes a realistic profit target and an exit strategy for when the market turns against them.

Some investors may find value in futures trading for the ability to hedge against exposure to an underlying commodity or index. For example, an investor who is bearish on the stock market may short-sell a futures contract for the Standard & Poor’s 500 in order to balance out their exposure to the index.

Another potential use for futures is as a way to speculate on the market without having to actually own the underlying asset. For example, an investor could buy a futures contract for jet fuel and then sell it at the spot price when the contract expires. This is known as a naked futures trade, and it’s common amongst speculators and investors who are looking to make money off of market movements rather than on the actual physical delivery of the commodity. For this reason, the futures market is a busy and liquid place to trade. However, it’s important to remember that the gains and losses in a futures contract aren’t capped at the original purchase price, so this type of speculation should only be undertaken with a significant amount of capital and appropriate risk tolerance.